The COVID-19 pandemic continues to be an ongoing nationwide emergency, with President Trump making an emergency declaration under the Stafford Act. By making such declaration, the opportunity has opened up for employers to provide tax-free assistance to their employees under the provisions of the Internal Revenue Code (Code).
Section 139 of the Code applies to disaster relief payments. Under the provisions of section 139(a), gross income does not include any amount received by an individual as a qualified disaster relief payment. In addition, under section 139(d), qualified disaster relief payments are not treated as net earnings from self-employment, wages or compensation subject to tax. This means that if the employee receives such a payment, that payment is tax-free to the employee. In addition, employers can deduct section 139 payments as ordinary and necessary business expenses under section 162.
What is a qualified disaster relief payment?
For purposes of section 139, the term qualified disaster relief payment means any amount paid to or for the benefit of an individual:
- to reimburse or pay reasonable and necessary personal, family, living or funeral expenses incurred as a result of a qualified disaster;
- to reimburse or pay reasonable and necessary expenses incurred for the repair or rehabilitation of a personal residence or repair/replacement of its contents to the extent that the need for such repair, rehabilitation or replacement is attributable to a qualified disaster;
- by a person engaged in the furnishing or sale of transportation as a common carrier by reason of the death or personal physical injuries incurred as a result of a qualified disaster; or
- if such amount is paid by a federal, state or local government or agency or instrumentality thereof in connection with a qualified disaster in order to promote the general welfare.
Further, qualified disaster relief payments do not include: (1) payments for expenses that are otherwise paid for by insurance or other reimbursements; or (2) income replacement payments, such as the payment of lost wages, lost business income or unemployment compensation.
As it relates to the COVID-19 pandemic, the reimbursable expenses to which the qualified disaster relief payments are being made must be incurred as result of the COVID-19 pandemic.
What types of employee expenses could the employer reimburse tax-free?
The IRS has not released specific guidance on how section 139 will apply as a result of the COVD-19 pandemic. However, the underlying purpose of this provision reasonably suggests that there are a number of expenses that could be reimbursed. For example, those expenses may include:
- medical expenses not covered by insurance, including co-pays and over-the-counter medicines;
- expenses incurred for child care and tutoring services;
- expenses incurred to allow the employee to work from home, including the cost of equipment, supplies and internet services;
- funeral expenses.
If your business is considering making qualified disaster relief payments to your employees, there are steps to consider that could help if the IRS audits the expense issue on the business income tax return. First, adopt a written plan. It would be beneficial to adopt a written plan for the reimbursement program. That plan should address who is eligible for reimbursement, what types of expenses are subject to reimbursement, procedures to seek reimbursement, etc. Second, keep in mind that the expenses must have been incurred by the employee as a result of the COVID-19 pandemic, and employees should be required to produce documentation in support of this element. Without support, the IRS could reclassify the payments made resulting in the payment being taxable to the employee and not deductible by the employer.
If you are considering taking advantage of section 139 to provide tax-free assistance to your employees, contact Varnum’s tax team to work through the details.